Cerence (CRNC): facing unprecedented competition from Apple

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Investment thesis

Cerence (NASDAQ: CRNC) has been a big winner from 2020 to 2021. The company has seen its share price rise from $17 in March 2020 to over $130 in February 2021, which is an increase of around 700%. However, when the market started to sell on high-growth tech stocks with a supply chain lockdown hurting company revenue, its share price fell. The stock price is now down more than 70% from its all-time high and is currently trading at $29.47.

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Cerence is a relatively unknown tech stock to most investors. It went public in 2019 as a spin-off from Nuance Communications, which was acquired by Microsoft (MSFT). Cerence is a leading company in the automotive assistant market. It provides white-label software that powers the in-car voice assistant, which creates smart, flexible and intuitive in-car experiences. The company works with some of the automotive industry’s largest OEMs such as Honda (HMC), Toyota (TM), Mercedes (OTCPK:DMLRY), and more.

Georges Massing, director of Daimler, on the Cerence partnership

“We work with Cerence as a partner and our teams have worked closely since the very beginning of our new Mercedes Benz User Experience project.”

Cerence continually improves the capabilities of its products. It introduced cloud services, a service that allows users to integrate their smartphones, smart homes and offices into their cars. Through the cloud, users can control the connected car by voice. It also pioneered voice biometrics, which allows the identification and verification of a user based on the characteristics of their voice. It is then able to provide advanced levels of customization based on their profile and preferences.

Cerence is enjoying huge success as the popularity of connected vehicles rapidly increases, increasing the need for in-vehicle interactive AI voice assistants. According to Wejo, the number of connected vehicles is growing rapidly. The number of connected vehicles has doubled from 103 million in 2017 to 226 in 2021 and is expected to reach 396 million in 2025. As most car manufacturers are reluctant to develop software in-house due to high R&D costs, they turn to Cerence for its white label solution. It also allows OEMs to collect more customer data through its software.

wejo

wejo

Competition

The competition has been relatively moderate so far, as the industry is quite niche. SoundHound (SOUN) is a competitor that recently went public through a SPAC merger. The company also provides conversational AI, but it does not specialize in the automotive industry. Apple (AAPL) and Amazon (AMZN) also have voice assistants like Siri and Alexa, but their capabilities are much weaker. However, at Apple’s WWDC last week, the tech giant announced that it would launch the next generation of Apple CarPlay in 2023, which I think could threaten Cerence’s position. Apple’s current CarPlay allows you to connect your device to the car to provide basic functions such as voice, media and maps.

The revamped CarPlay has a much bigger ambition. The new CarPlay can be fully integrated into the car’s native system and support its operating system and user interface. Details are yet to be fully disclosed, but features such as connected home device status are confirmed, which is capable of rivaling Cerence’s cloud service. The company also confirmed that it is already working with several OEMs including Audi, Porsche, Mercedes, Volvo, Polestar (GGPI), Renault, Ford (F), Nissan and Honda. The introduction of Apple CarPlay could allow OEMs to reduce their dependence on Cerence. They can simply use Apple’s operating system rather than paying Cerence for its white-label solution. It’s still a bit early to determine the full impact of this, but I think it will have a significant impact on Cerence, to say the least.

Apple Car Play

Apple’s WWDC

Finances and evaluation

The company’s financial performance has been very disappointing lately as the supply chain lockdown continues to weigh on the automotive industry. For the second quarter of 2022, the company reported revenue of $86.28 million, down 12.5% ​​year-on-year (year-over-year) from 98.7 millions of dollars. Non-GAAP gross margin decreased from 77% to 74.7%. Adjusted EBITDA fell from $39.3 million to $24 million, which represents a decrease of 38.9%. Net profit went from a positive amount of $11.2 million to a negative amount of (0.5) million dollars. The weak performance is largely due to the decline in car production. Variable licensing revenue was down 46% year-over-year and Connected Services revenue was down 8% year-over-year.

Tom Beaudoin, CFO on declining revenue:

Our variable license revenues decreased by 46% compared to the same quarter last year due to the combined effects of lower automotive production and consumption of fixed license contracts. Connected Services revenue was down 8% year-over-year, primarily due to lower revenue from our legacy contract, which was expected and previously announced, as well as lower automotive production .

Cerence

Cerence

On the positive side, the company recorded first-half booking of $448 million, up 53% year-on-year, representing an increase in revenue for the quarters ahead. Third-quarter revenue is expected to be around $91 million, up 6.1% sequentially but down 5.8% year-on-year. Non-GAAP gross margins are expected to improve slightly to 76%, and the company is expected to generate adjusted EBITDA of $28 million and revenue of approximately $7.5 million. This signals some improvements over previous quarters, but performance remains weak compared to past years.

Stefan Ortmanns, CEO, on future prospects

Second, we remain intensely committed to delighting our customers by continuing to deliver high quality products and implementations on time and on budget. We are firmly focused on delivering successful launches of several key customer programs, which will position us for future success. And part of that, we expect a significant increase in professional services revenue for the second half of the year, which is another leading indicator of future business potential.

After the massive stock price drop, the company now trades at a forward PE ratio of 15.6, which is very cheap for a software company that historically trades at around 40 times its earnings. There are no public companies with a similar activity, so it is difficult to compare it with others. I think the valuation is compelling in its future growth. Due to supply chain issues, the company already forecast FY22 revenue to be down about 4% and EPS to be down about 25% year-on-year. If the company continues to perform poorly, the PE ratio will only go up as the E decreases. FY23 should be a relatively easy year for Cerence due to much weaker lineups. Fiscal 24 should be the true indicator of Cerence’s ability to execute and re-accelerate growth. If they are successful, I think a valuation expansion is almost guaranteed.

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Macro-risks

Besides the threat from Apple, Cerence is also highly exposed and sensitive to the macro environment. It faces multiple supply chain headwinds, inflation and the possibility of a recession. The supply chain blockage has been a huge problem as it has significantly slowed down the process of manufacturing new cars from OEMs. Cerence’s revenue is volume-based, so fewer cars made means less revenue and bookings. China is finally starting to reopen after a long period of confinement under its “zero covid” policy. This may help ease the supply chain bottleneck, but the outlook remains highly uncertain due to the ongoing war between Ukraine and Russia, which is also affecting auto production. As inflation persists and car prices remain at high levels, consumers may be reluctant to buy a new car at some point as the prices of everything rise and they need to save more money for it. essential. It will get even worse if a recession hits, leading to massive layoffs. We are already seeing companies stop hiring or even lay off employees. This will result in very weak demand for new cars.

Conclusion

In conclusion, I believe Cerence is a grip. The company has had a great run in recent years due to its leading position in the market with the continuous launch of new products. The connected vehicle market is also expected to grow in the coming years, which has accelerated the need for in-vehicle AI voice assistants. However, the company performed poorly due to significant supply chain disruption, which slowed automotive production from OEMs. It also faces multiple headwinds, including competition from Apple and the highly uncertain macroeconomic environment. Apple’s revamped CarPlay operating system announced at WWDC will now compete with Cerence, and it has already entered into partnerships with several Tier 1 OEMs. weakens and may even soon face a recession. The current PE is low, but its cheapness highly depends on its future performance. I value the business as a hold at the current price.

Martin E. Berry